NEW YORK, April 21(Reuters) - A U.S. appeals court is set hear a case whose outcome could make it harder for the government to prosecute insider trading and potentially jeopardize several high-profile guilty verdicts, including that of SAC Capital Advisors portfolio manager Michael Steinberg.

The question facing the 2nd U.S. Circuit Court of Appeals in New York on Tuesday is one that has divided lower court judges: whether to be convicted of insider trading, the recipient of non-public information must know that the source of the tip benefited from the disclosure.

The issue is at the heart of the appeal brought by Todd Newman, a former portfolio manager at the hedge fund Diamondback Capital Management, and Anthony Chiasson, co-founder of the hedge fund Level Global Investors.

Newman and Chiasson were convicted in 2012 for their roles in a scheme prosecutors said reaped $72 million in illicit profits after trading on inside information about Dell Inc and Nvidia Corp.

The government said Newman, 46, and Chiasson, 49, traded on tips they received from analysts who worked at their hedge funds.

These analysts, the government said, were part of a "corrupt circle" of investment firm analysts that traded non-public information obtained from insiders at various companies, including Dell and Nvidia.

Newman has been sentenced to 4-1/2 years in prison, and Chiasson faces a 6-1/2 year term. Both men have been free on bail pending their appeal.

A ruling reversing Newman and Chiasson's convictions would mark a significant setback for Manhattan U.S. Attorney Preet Bharara, whose office has secured insider trading convictions of 80 individuals since October 2009.

PERSONAL BENEFITS

The U.S. Supreme Court in 1983 held that a "tippee" can only be found to have engaged in insider trading if the tipper benefited from the disclosure.

The issue the 2nd Circuit is being asked to address is whether prosecutors must show the tippee knew of the tipper's benefit, which can be financial or non-monetary.

"It's a significant question both in terms of giving guidance to the business community and in terms of whether prosecutors are trying to stretch the securities laws too far," said John Buretta, a lawyer at Cravath, Swaine & Moore who is not involved in the case.

At Newman and Chiasson's 2012 trial, U.S. District Judge Richard Sullivan in Manhattan declined their lawyers' request to instruct the jury that for the men to be found guilty, prosecutors needed to prove they knew the insiders benefited.

He gave a similar instruction in the case of Michael Steinberg, a SAC Capital portfolio manager convicted in December in a case that involved the same alleged "corrupt circle" of analysts.

OPPOSITE CONCLUSION

Newman and Chiasson's lawyers contend that Sullivan misconstrued the law. In appellate briefs, the lawyers cite rulings in which four other judges from Manhattan federal court came to the opposite conclusion from Sullivan.

Stephen Fishbein, a lawyer for Newman, told the 2nd Circuit during arguments over bail in June that whether his client faces jail "should not depend on what judge we drew and where that judge comes down on a hotly debated issue that the courts haven't decided."

In the Whitman case, for example, U.S. District Judge Jed Rakoff in 2012 said prosecutors must show the tippee knew the tipster benefited from the disclosure, rejecting the government's arguments that requiring such proof could allow insider traders to avoid prosecution.

Rakoff wrote that while it may be an "unfortunate 'loophole,' it is a product of the topsy-turvy way the law of insider trading has developed in the courts and cannot be cured short of legislation."

The 2nd Circuit upheld Whitman's conviction in February. Newman and Chiasson have seized on language in that ruling, which said the appeals court had not yet ruled on whether a tippee must have knowledge of the benefit.

Lawyers for Newman and Chiasson declined comment, as did a spokeswoman for Bharara.

RIPPLE EFFECTS

Should Newman and Chiasson win a new trial or acquittal, the ruling could have ripple effects.

Steinberg's lawyers would likely rely on such a ruling to argue that his conviction should be overturned.

Barry Berke, a lawyer for Steinberg, declined comment. But early on he had objected to Steinberg's case being assigned to Sullivan, saying last year that he was concerned the government sought to put the case before him "because of that legal issue that is obviously hotly disputed."

Meanwhile, lawyers for Rengan Rajaratnam, the younger brother of Raj Rajaratnam who was charged with insider trading in March 2013, have cited the Newman and Chiasson case in arguing the government failed to allege Rajaratnam knew two alleged tippers received personal benefits.

U.S. District Judge Naomi Reice Buchwald on Friday rejected Rajaratnam's bid to dismiss the indictment against him for lack of allegations he knew the insiders benefited. But she acknowledged she would need to address before trial what the jury needed to find regarding knowledge of the benefits.

Daniel Gitner, Rajaratnam's lawyer, did not respond to requests for comment. Trial in Rajaratnam's case is scheduled for June 17.

The case is U.S. v. Newman, 2nd U.S. Circuit Court of Appeals, No. 13-1837. (Reporting by Nate Raymond in New York; Editing by Noeleen Walder, Amy Stevens, Chizu Nomiyama and Gunna Dickson)

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